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An Indian court passed a ruling that allows Flipkart to deduct all marketing and promotional
expenses from its taxable income—an outcome that will drastically reduce the e-commerce
giant’s tax bill.

The Bangalore Income Tax Appellate Tribunal on April 24 struck down the Indian tax
authority’s claim that marketing and promotional expenses incurred by Flipkart India
Pvt. Ltd. added to its brand value and should therefore be classified as capital expenditure.

The ruling spares Flipkart from a $16.4 million tax demand.

The ruling was highly anticipated, as the outcome impacts all companies vying for
a slice of India’s booming online retail market. It is a major win for e-commerce
companies like Flipkart and Amazon.com Inc., which use heavy discounts and promotional
offers to up sales, practitioners told Bloomberg Tax.

“This ruling is very important from the perspective that, product discounting, advertisement,
and marketing expenses constitute a major portion of expenses of e-commerce companies,
which they incur on day to day basis,” Rakesh Nangia, managing partner at Nangia &
Co. LLP, said April 25.

Characterizing Expenses

Indian tax law has deemed brand promotional expenses to be revenue expenses because
they generate sales essential to business operations. Capital expenditures, such as
asset purchases, are strategic and add to the long-term value of the company and are
therefore taxable, practitioners said.

“E-commerce companies have to use these promotional methods in order to capture the
attention of Indian consumers — it is not up to the tax officer to step into the businessman’s
shoes and determine how to characterize the expenses,” Nangia said.

Indian tax authorities claimed that Flipkart was deducting expenses that were related
to building and promoting their brand, and ultimately contributing to its overall
valuation, according to
court documents. The assessing officer made an original tax adjustment of $209.4 million to the company’s
taxable income from assessment year 2015-16.

Upon appeal by Flipkart, the commissioner of income-tax appeals upheld that the expenses
were taxable but reduced the adjustment for assessment year 2015-16 to $199 million,
which gave rise to the $16.4 million tax bill, according to the court document.

“It is very common practice for the tax department to recharacterize advertising,
marketing, and promotional expenses and we’ve seen many cases go through the tax courts
arguing this tax principle,” Nangia said.

Practitioners said that even though the principles being debated are common in tax
courts, the tax department lacks precedent when it comes to e-commerce companies like
Flipkart and Amazon because the industry is still growing.

“The matter could still be taken appealed by the tax department, so we’ll have to
see if the tax department agrees with the ITAT’s decision,” Nangia said.

‘Lacking Precedent’

Practitioners said that even though the principles being debated are common in tax
courts, the tax department lacks precedent when it comes to e-commerce companies like
Flipkart and Amazon because the industry is still burgeoning in India.

“The principles being debated are actually quite clear. Companies need to sustain
and retain their normal levels of revenue and that leads to day-to-day expenses, and
in the case of e-commerce that means daily discounts,” Rohit Kapur, managing director
at Dezan Shira & Associates, said April 25.

Kapur said tax officers were “misguided” when making their additions to Flipkart’s
income because the same transfer pricing principles that apply to brick-and-mortar
retailers should apply to e-commerce companies, even if matters like start-up valuation
make things more complicated. Flipkart is currently valued at about $12 billion—and
rising, according to various media reports.

“Anything any company does is in the nature of creating and maintaining brand value,
so just because it is a huge amount that is happening online doesn’t give tax officers
the right to step in and demand tax,” Kapur said.

Since marketing expenses and company value go hand-in-hand, tax officers could revive
the demand in an appeal before a higher court, practitioners said.

“Tax officers should leave it but given the pressure coming from the revenue department
they could test the limits of the jurisprudence on the matter,” Kapur said.

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